The Silver Fox Gets Us Ready For A Rate Hike

To update, the Fed has increased the fed funds rate 25 basis points to 1 percent as of March 15. Read more here.

Whether or not the Silver Fox is just teasing as usual, it is definitely time for millennials to experience a rate hike with interest rates above zero.

On March 3, the Fed’s head honcho, Janet Yellen, gave a speech that overwhelmed any lingering doubts of postponing a hike in the fed funds rate. To quote from her speech,

“Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.”

Tell me again, “What’s the fed funds?”

Just to refresh, the fed funds rate, aka the mother of all interest rates, is the interest rate banks charge each other on loans overnight. They do this while we sleep in order to make sure they have the required amount of reserve funds to start the day. The Fed sets the reserve requirement to keep banks from loaning out every dollar they have, keeping them somewhat liquid in case a bunch of depositors go on a drug run and need to withdraw a ton of cash.

When the fed funds rate increases, it is essentially making money more expensive. Though it does not immediately affect the stock market or interest rates for business loans, homes and credit cards, the ripple effect is felt in all these areas. If the cost of borrowing increases for banks, odds are that all loans will become a bit more expensive as well. This can negatively affect the bottom line for businesses that use loans to expand their operations, thus taking a hit in their stock price.

Nonetheless, there are benefits to making money more expensive by increasing the fed funds rate.

Benefit #1

The Fed decreases the rate as a way to stimulate the economy, particularly to combat recessions. Economists have been pointing out that we are due for another recession. With rates so low, the Fed wouldn’t be able to use the fed funds rate as a way to get out, making the recession hurt much more.

Benefit #2

Though the low interest rates make big purchases more affordable, they also make it harder for people to save. Increasing the interest rate will make it easier for folks to actually follow that cliche how-to-get-rich advice of “don’t work for your money, have your money work for you.” People are much more likely to save in safer investment vehicles such as bonds, Treasury bills and certificates of deposit (CDs).

Benefit #3

What happens when save more is that we become less likely to borrow. The low interest rates have exacerbated how much debt we hold. Check out the table produced by MarketWatch. Federal debt has ballooned along with personal and corporate debt. It’s time to reverse this trend, or we’ll have a big price to pay down the line.

Benefit #4

Making money more expensive by increasing the interest rate is also known as making our currency stronger. This incentivizes foreigners to invest in the U.S. where they can receive higher returns on their investments. Additionally, this may combat some of the protectionist policies that may be down the pipeline by making imports more affordable.

Takeaway

At first glance, an increase in the fed funds rate looks kind of scary, especially for those already drowning in debt. But, it’s not just the Fed that influences interest rates. Market forces, such as China and other big players are saving less, which help push interest rates up. Low interest rates have investors looking for higher interest rates in riskier markets, have regular people spending more on borrowed money and bloat up the value of assets with “cheap money.”

The Silver Fox says the economy is looking strong (whatever that means). Nonetheless, we’re ready to reverse this trend, even if it hurts a little.

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Published by Kevin D. Gomez

Kevin D. Gomez is an Instructor of Economics at Creighton University and Program Manager at the Institute for Economic Inquiry. He received his B.S. in Economics and Statistics from Florida State University and his M.A. from George Mason University. Trying to pay it forward by helping noneconomists make sense of the crazy world.
View all posts by Kevin D. Gomez

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